Dr. Alice Mills was thinking of selling her veterinary practice in Lexington, Ky., this year, but she decided to put the move off because she worried that it would be difficult to sell in an era of rising interest rates.
“In a year, I think that there’s going to be less anxiety about the interest rates, and I’m hoping that they’re going to go down,” Dr. Mills, 69, said. “I have to put my faith in the fact that the practice will sell.”
Dr. Mills is one of many Americans anxiously wondering what comes next for borrowing costs — and the answer is hard to guess.
It is expensive to take out a loan to buy a business or a car in 2023. Or a house: Mortgage rates are around 7 percent, up sharply from 2.7 percent at the end of 2020. That is the result of the Federal Reserve’s campaign to cool the economy.
The central bank has lifted its policy interest rate to a range of 5.25 to 5.5 percent — the highest level in 22 years — which has trickled out to increase borrowing costs across the economy. The goal is to deter demand and force sellers to stop raising prices so much, slowing inflation.
But nearly a year and a half into the effort, the Fed is at or near the end of its rate increases. Officials have projected just one more in 2023, by a quarter of a point, and the president of the Federal Reserve Bank of New York, John C. Williams, said in an interview that he didn’t see a need for more than that.
“We’re pretty close to what a peak rate would be, and the question will really be — once we have a good understanding of that — how long will we need to keep policy in a restrictive stance, and what does that mean?” Mr. Williams said on Aug. 2.
The economy is approaching a pivot point, one that has many consumers wondering when rates will come back down, how quickly and how much.
“Eventually monetary policy will need over the next few years to get back to a more normal — whatever that normal is — a more normal setting of policy,” Mr. Williams said.
So far, the jury is out on what normal means. Fed officials do expect to cut interest rates next year, but only slightly — they think it could be several years before rates return to a level between 2 and 3 percent, like their peak in the years before the pandemic. Officials do not forecast a return to near zero, like the setting that allowed mortgage rates to sink so low in 2020.
That’s a sign of optimism: Rock-bottom rates are seen as necessary only when the economy is in bad shape and needs to be resuscitated.
In fact, some economists outside the Fed think that borrowing costs might remain higher than they were in the 2010s. The reason is that what has long been known as the neutral rate — the point at which the economy is not being stimulated or depressed — may have risen. That means today’s economy may be capable of chugging along with a higher interest rate than it could previously handle.
A few big changes could have caused such a shift by increasing the demand for borrowed money, which props up borrowing costs. Among them, the government has piled on more debt in recent years, businesses are shifting toward more domestic manufacturing — potentially increasing demand for factories and other infrastructure — and climate change is spurring a need for green investments.
Whether that proves to be the case will have big implications for American companies, consumers, aspirational homeowners and policymakers alike.
Kristin Forbes, an economist at the Massachusetts Institute of Technology, said it was important not to be too precise about guessing the neutral rate — it moves around and is hard to recognize in real time. But she thinks it might be higher than it was in the 2010s. The economy back then had gone through a very weak economic recovery from the Great Recession and struggled to regain its vigor.
“Now, the economy has learned to function with higher interest rates,” Ms. Forbes said. “It gives me hope that we’re coming back to a more normal equilibrium.”
Many economists think slightly higher rates would be a good thing. Before the pandemic, years of steadily declining demand for borrowed money depressed rates, so the Fed had to cut them to rock bottom every time there was an economic crisis to try to encourage people to spend more.
Even near-zero rates couldn’t always do the trick: Growth recovered only slowly after the 2008 recession despite the Fed’s extraordinary efforts to coax it back.
If demand for money is slightly higher on a regular basis, that will make it easier to goose the economy in times of trouble. If the Fed cuts rates, it will pull more home buyers, entrepreneurs and car purchasers off the sidelines. That would lower the risk of economic stagnation.
To be sure, few if any prominent economists expect rates to stay at higher levels like those that prevailed in the 1980s and 1990s. Those who expect rates to stay elevated think the Fed’s main policy rate could hover around 4 percent, while those who expect them to be lower see something more in the range of 2 to 3 percent, said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington.
That is because some of the factors that have pushed rates down in recent years persist — and could intensify.
“Several of the explanations for the decline in long-term interest rates before the pandemic are still with us,” explained Lukasz Rachel, an economist at University College London, citing things like an aging population and low birthrates.
When fewer people need houses and products, there is less demand for money to borrow to construct buildings and factories, and interest rates naturally fall.
Such factors are enough for Mr. Williams, the New York Fed president, to expect neutral rates to stick close to their prepandemic level. He also pointed to the shift toward internet services: Streaming a movie on Netflix does not require as much continuing investment as keeping video stores open and stocked.
“We are moving more and more to an economy that doesn’t need factories and lots of capital investment to produce a lot of output,” Mr. Williams said, later adding that “I think the neutral rate is probably just as low as it was.”
That has some big implications for monetary policy. When inflation of around 3 percent is stripped out, the Fed’s policy rate sits at about 2.25 to 2.5 percent in what economists call “real” terms. That is well above the setting of 1 percent or less that Mr. Williams sees as necessary to start weighing on the economy.
If price increases continue to fall, the Fed will inadvertently be clamping down on the economy harder in that “real” sense if it holds its policy interest rate steady, Mr. Williams said. That means officials will need to cut rates to avoid overdoing it, he said — perhaps even as soon as early next year.
“I think it will depend on the data, and depend on what’s happening with inflation,” Mr. Williams said when asked if the Fed might lower interest rates in the first half of 2024. “If inflation is coming down, it will be natural to bring” the federal funds rate “down next year, consistent with that, to keep the stance of monetary policy appropriate.”
For Dr. Mills, the Kentucky veterinarian, that could be good news, bringing partial retirement that much closer.
“I would love to get back into zoo work,” she said, explaining that she had worked with big cats early in her career and would love to do so again once she sold her practice — which is itself cats only. “That’s something for retirement.”